2 The Political Economy of International TradeChapter 6The Political Economy of International Trade

3 IntroductionFree trade refers to a situation where a government does not attempt to restrict what its citizens can buy from another country or what they can sell to another countryWhile many nations are nominally committed to free trade, they tend to intervene in international trade to protect the interests of politically important groups

4 Instruments of Trade PolicyQuestion: How do governments intervene in international trade?There are seven main instruments of trade policyTariffsSubsidiesImport quotasVoluntary export restraintsLocal content requirementsAntidumping policiesAdministrative policies

5 TariffsA tariff is a tax levied on imports that effectively raises the cost of imported products relative to domestic productsSpecific tariffs are levied as a fixed charge for each unit of a good importedAd valorem tariffs are levied as a proportion of the value of the imported good

6 Tariffs Question: Why do governments impose tariffs? Tariffsincrease government revenuesprovide protection to domestic producers against foreign competitors by increasing the cost of imported foreign goodsforce consumers to pay more for certain importsSo, tariffs are unambiguously pro-producer and anti-consumer, and tariffs reduce the overall efficiency of the world economy

7 Classroom Performance SystemA tariff levied as a fixed charge for each unit of a good imported is a(n)Fixed tariffSpecific tariffAd valorem tariffTransit tariffClassroom Performance System Answer: a

8 Subsidies A subsidy is a government payment to a domestic producerSubsidies help domestic producerscompete against low-cost foreign importsgain export marketsConsumers typically absorb the costs of subsidiesCountry Focus: Subsidized Wheat Production in JapanSummaryThis feature explores the subsidies Japan continues to pay its wheat farmers. Tens of thousands of Japanese farmers continue to grow wheat despite the fact that the wheat grown in North America, Argentina, and Australia is far cheaper and of superior quality. The Japanese farmers stay in business thanks to the hefty subsidies paid by the Japanese government. As a result, wheat prices in Japan are substantially higher than they would be if a free market were allowed to operate.Suggested Discussion Questions1. Who are the winners and who are the losers from Japanese wheat subsidies?Discussion Points: Students will probably recognize that, as is usually the case with protectionist measures, the subsidies Japan pays its wheat farmers benefit the farmers, but cost the average consumer in the form of higher wheat prices. In fact, in 2004, Japanese consumers covered $700 million in subsidies! The subsidies also limit imports of wheat, which negatively affects foreign wheat farmers.2. Why does Japan continue to subsidize its wheat farmers when cheaper wheat is readily available in international markets?Discussion Points: Thanks to subsidies, wheat prices in Japan are between 80 and 120 percent higher than they are in world markets. In fact, if the subsidies were eliminated, Japanese wheat production would cease entirely. However, at least for now, because politicians count on the votes of the wheat farmers, there appears to be no plan to end the subsidies.Teaching Tip: To extend this discussion, consider discussing Japan’s role in the production of rice. For more on this, go to {http://www.businessweek.com/globalbiz/content/may2008/gb _ htm?chan=search}, and {http://www.businessweek.com/globalbiz/content/may2008/gb _132137_page_2.htm}.

9 Import Quotas and Voluntary Export RestraintsAn import quota is a direct restriction on the quantity of some good that may be imported into a countryTariff rate quotas are a hybrid of a quota and a tariff where a lower tariff is applied to imports within the quota than to those over the quotaVoluntary export restraints are quotas on trade imposed by the exporting country, typically at the request of the importing country’s governmentA quota rent is the extra profit that producers make when supply is artificially limited by an import quota

11 Local Content RequirementsA local content requirement demands that some specific fraction of a good be produced domesticallyThe requirement can be in physical terms or in value termsLocal content requirements benefit domestic producers and jobs, but consumers face higher prices

12 Administrative PoliciesAdministrative trade polices are bureaucratic rules that are designed to make it difficult for imports to enter a countryThese polices hurt consumers by denying access to possibly superior foreign products

13 Administrative PoliciesDumping is selling goods in a foreign market below their cost of production, or selling goods in a foreign market at below their “fair” market valueIt can be a way for firms to unload excess production in foreign marketsSome dumping may be predatory behavior, with producers using substantial profits from their home markets to subsidize prices in a foreign market with a view to driving indigenous competitors out of that market, and later raising prices and earning substantial profits

14 Administrative PoliciesAntidumping polices are designed to punish foreign firms that engage in dumpingThe goal is to protect domestic producers from “unfair” foreign competitionU.S. firms that believe a foreign firm is dumping can file a complaint with the governmentIf the complaint has merit, antidumping duties, also known as countervailing duties may be imposedManagement Focus: U.S. Magnesium Seeks ProtectionSummaryThis feature explores the dumping charged levied by U.S. Magnesium against Chinese and Russian producers. According to U.S. Magnesium, the sole American producer of magnesium, Russian and Chinese producers were selling magnesium significantly below market value in an effort to drive U.S. Magnesium out of business. The company failed a complaint with the International Trade Commission (ITC) which ultimately ruled in favor of U.S. Magnesium.Suggested Discussion Questions1. What is dumping? Were Chinese and Russian producers guilty of dumping? How did U.S. Magnesium justify its claims against Russian and Chinese producers?Discussion Points: Dumping is defined as selling goods in a foreign market below the cost of production, or below fair market value. In 2004, U.S. Magnesium claimed that China and Russia had been dumping magnesium in the United States. The company noted that in 2002 and 2003, magnesium imports rose, and prices fell. While the ITC ruled in favor of the American company, some students might question whether the fact that the Chinese could sell their product at low prices might simply reflect the country’s significantly lower wage rates.2. What does the ITC’s ruling mean for American consumers of magnesium? In your opinion, was the ruling fair?Discussion Points: The ITC ruled in favor of U.S. Magnesium finding that indeed China and Russia had been dumping their product in the United States. Fines ranging from 50 to 140 percent on imports were imposed against China, and 19 to 22 percent on Russian companies. Most students will note that while the ITC’s decision is a good one for U.S. Magnesium and its employees. for consumers, the ruling means magnesium prices that are significantly higher than those in world markets. Students will probably argue that this result is unfair, and should be revisited.Teaching Tip: U.S. Magnesium’s web site is available at {http://www.usmagnesium.com/}.

16 The Case for Government InterventionQuestion: Why do governments intervene in trade?There are two types of argumentsPolitical arguments are concerned with protecting the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers)Economic arguments are typically concerned with boosting the overall wealth of a nation (to the benefit of all, both producers and consumers)

17 Political Arguments for InterventionPolitical arguments for government intervention includeprotecting jobsprotecting industries deemed important for national securityretaliating to unfair foreign competitionprotecting consumers from “dangerous” productsfurthering the goals of foreign policyprotecting the human rights of individuals in exporting countriesCountry Focus: Trade in Hormone-Treated BeefSummaryThis feature describes the trade battle between the United States and the European Union over beef from cattle that have been given growth hormones. It outlines the basic issues that led to the dispute, and shows how the World Trade Organization has treated the case.Suggested Discussion Questions1. Why is the European Union so concerned about beef from cattle that have been given growth hormones?Discussion Points: Some students may argue that the European Union’s ban on growth hormones in cattle was little more than a thinly veiled form of protectionism. Australia, New Zealand, and Canada, which also use the hormones in their cattle industry, were also affected by the ban. The European Union claimed that it was merely protecting the health of its citizens, however studies showed that the hormones posed no health issues for people.2. Why did the WTO rule against the European Union?Discussion Points: The World Trade Organization ruled against the European Union stating that the European Union’s ban on imported hormone treated beef had no scientific justification. Even so, the European Union refused to lift the ban, which had strong public support, and in the end, the European Union was assessed punitive tariffs. The European Union held on to its principles though, and as of 2008, continued to maintain its restrictions on hormone treated beef despite the resulting punitive tariffs.Teaching Tip: The WTO maintains a site for students. Go to {www.wto.org} and click on the students icon to search the site, research countries, and even see a list of internships that are available at the WTO.

18 Political Arguments for Intervention1. Protecting jobs and industriesThis is the most common political reason for trade restrictionsThis is typically the result of political pressures by unions or industries that are "threatened" by more efficient foreign producers, and have more political clout than the consumers who will eventually pay the costs

19 Political Arguments for Intervention2. National SecurityGovernments sometimes protect certain industries such as aerospace or advanced electronics because they are important for national securityThis argument is less common today than in the past

20 Political Arguments for Intervention3. RetaliationWhen governments take, or threaten to take, specific actions, other countries may remove trade barriersThis can be a risky strategyIf threatened governments don’t back down, tensions can escalate and new trade barriers may be enacted

21 Political Arguments for Intervention4. Protecting ConsumersProtecting consumers from unsafe products is also be an argument for restricting importsThis often involves limiting or banning the import of certain products

22 Political Arguments for Intervention5. Furthering Foreign Policy ObjectivesTrade policy can be used to support foreign policy objectivesPreferential trade terms can be granted to countries that a government wants to build strong relations withRogue states that do not abide by international laws or norms can be punishedHowever, it might cause other countries to undermine unilateral trade sanctionsTwo acts, the Helms-Burton Act and the D’Amato Act, have been passed to protect American companies from such actions

23 Political Arguments for Intervention6. Protecting Human RightsGovernments can use trade policy to improve the human rights policies of trading partnersUnless a large number of countries choose to take such action, however, it is unlikely to prove successfulSome critics have argued that the best way to change the internal human rights of a country is to engage it in international tradeThe decision to grant China MFN status in 1999 was based on this philosophy

25 Economic Arguments for Intervention1. The infant industry argumentThe infant industry argument suggests that an industry should be protected until it can develop and be viable and competitive internationallyThis has been accepted as a justification for temporary trade restrictions under the WTOHowever, this argument has been criticized becauseit is useless unless it makes the industry more efficientif a country has the potential to develop a viable competitive position, its firms should be capable of raising necessary fundsCritics argue that

26 Economic Arguments for Intervention2. Strategic Trade PolicyStrategic trade policy suggests that in cases where there may be important first mover advantages, governments can help firms from their countries attain these advantagesStrategic trade policy also suggests that governments can help firms overcome barriers to entry into industries where foreign firms have an initial advantage

27 Classroom Performance SystemWhich argument for government intervention suggests that an industry should be protected until it can develop and be viable and competitive internationally?Strategic trade policyNational securityRetaliationInfant industryClassroom Performance System Answer: d

28 The Revised Case for Free TradeNew trade theorists believe government intervention in international trade is justifiedClassic trade theorists disagreeSome new trade theorists believe that while strategic trade theory is appealing in theory, it may not be workable in practice – they suggest a revised case for free tradeTwo situations where restrictions on trade may be inappropriateRetaliationDomestic Policies

29 Retaliation and WarKrugman argues that strategic trade policies aimed at establishing domestic firms in a dominant position in a global industry are beggar-thy-neighbor policies that boost national income at the expense of other countriesA country that attempts to use such policies will probably provoke retaliationA trade war could leave both countries worse off

30 Domestic Policies Governments can be influenced by special interestConsequently, a government’s decision to intervene in a market may appease a certain group, but not necessarily the support the interests of the country as a whole

31 Development of the World Trading SystemSince World War II, an international trading framework has evolved to govern world tradeIn its first fifty years, the framework was known as the General Agreement on Tariffs and Trade (GATT)Since 1995, the framework has been known as the World Trade Organization (WTO)Country Focus: Estimating the Gains from Trade for AmericaSummaryThis feature explores the results of a study by the Institute for International Economics. The study, which estimated the gains to the U.S. economy from free trade, found that the United States’ GDP was more than 7 percent higher as a result of reductions in trade barriers than it would have been if the barriers remained. The study also estimated that if tariffs were reduced to zero, significant gains would still result.Suggested Discussion Questions1. What does the Institute for International Economics suggest about the benefits of free trade?Discussion Points: The Institute for International Economics found that thanks to reductions in trade restrictions, the United States’ GDP was up. The Institute also estimated that even greater gains in the country’s GDP would occur if protectionism was eliminated all together. Students should recognize that these findings follow the principles of Adam Smith and David Ricardo and suggest that free trade is beneficial.2. According to the Institute for International Economics study, a move toward free trade would cause disruption in employment. Is it still worth pursuing free trade if it means that some people lose their jobs?Discussion Points: This question should prompt a strong debate among students. Some students will probably suggest that the costs in terms of lost wages and benefits associated with free trade outweigh the benefits that would be gained. Other students however, will probably argue that since protectionism typically benefits only a few at the expense of others, while free trade generates greater economic growth and higher wages, a free trade policy should be followed.Teaching Tip: The Web site for Institute for International Economics is available at {http://www.iie.com/}.

32 From Smith to the Great DepressionUp until the Great Depression of the 1930s, most countries had some degree of protectionismIn 1930, the U.S. enacted the Smoot-Hawley Act, which created significant import tariffs on foreign goodsOther nations took similar steps and as the depression deepened, world trade fell further

33 1947-1979: GATT, Trade Liberalization, and Economic GrowthAfter WWII, the U.S. and other nations realized the value of freer trade, and established the General Agreement on Tariffs and Trade in 1947The approach of GATT (a multilateral agreement to liberalize trade) was to gradually eliminate barriers to tradeGATT’s membership grew from 19 to more than 120 nationsTariff reduction was spread over eight rounds of negotiationGATT regulations were enforce by a mutual monitoring system

34 1980-1993: Protectionist TrendsThe world trading system came under strain during the 1980s and early 1990s becauseJapan’s economic success strained what had been more equal trading patternsPersistent trade deficits by the U.S caused significant problems in some industries and political problems for the governmentMany countries found that although GATT limited the use of tariffs, there were many other forms of intervention that had the same effect that did not technically violate GATT

35 The Uruguay Round and the World Trade OrganizationThe Uruguay Round (1986) focused on1. Services and Intellectual PropertyTrade issues related to services and intellectual property and agriculture were emphasized2. The World Trade OrganizationThe WTO was established as a more effective policeman of the global trade rulesThe WTO encompassed GATT and the General Agreement on Trade in Services (GATS) and the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS)

36 WTO Experience to DateSince its establishment, the WTO has emerged as an effective advocate and facilitator of future trade deals, particularly in such areas as servicesSo far, most countries have adopted WTO recommendations for trade disputesThe WTO has brokered negotiations to reform the global telecommunications and financial services industriesThe 1999 meeting of the WTO in Seattle demonstrated that issues surrounding free trade have become mainstream, and dependent on popular opinionInternet Extra: The WTO site {http://www.wto.org} provides a wealth of information on current trade issues. Go to the site, and click on Trade Topics.Browse down the menu to explore the current situation at the Doha Round, the status of talks on electronic commerce, or the WTO’s current efforts regarding trade and the environment.

37 The Future of the WTO: Unresolved Issues and the Doha RoundThe WTO is currently focusing on1. Anti-dumping policiesThe WTO is encouraging members to strengthen the regulations governing the imposition of antidumping duties2. Protectionism in agricultureThe WTO is concerned with the high level of tariffs and subsidies in the agricultural sector of many economies3. Protecting intellectual propertyMembers believe that the protection of intellectual property rights is essential to the international trading systemTRIPS obliges WTO members to grant and enforce patents lasting at least 20 years and copyrights lasting 50 years

38 The Future of the WTO: Unresolved Issues and the Doha Round4. Market access for nonagricultural goods and servicesThe WTO would like to bring down tariff rates on nonagricultural goods and services, and reduce the scope for the selective use of high tariff rates5. A new round of talks: DohaThe WTO launched a new round of talks in 2001 to focus oncutting tariffs on industrial goods and servicesphasing out subsidies to agricultural producersreducing barriers to cross-border investmentlimiting the use of anti-dumping laws

39 Classroom Performance SystemThe main issues on the table at the Doha Round include all of the following exceptAnti-dumping policiesProtectionism in agricultureIntellectual property rightsInfant industry protectionClassroom Performance System Answer: d

40 Implications for ManagersQuestion: Why should international managers care about the political economy of free trade or about the relative merits of arguments for free trade and protectionism?Trade barriers impact firm strategyFirms can play a role in promoting free trade or trade barriers

41 Trade Barriers and Firm StrategyTrade theory suggests why dispersing production activities globally can be beneficialHowever, trade barriers may limit a firm’s ability to do soTrade barriers raise the cost of exportingQuotas limit exportsFirms may have to locate production activities within a country to meet local content regulationsThe threat of future trade barriers can influence firm strategyAll of these can raise costs above what they may have been in a world of free trade

42 Policy ImplicationsInternational firms have an incentive to lobby for free trade, and keep protectionist pressures from causing them to have to change strategiesWhile there may be short run benefits to having government protection in some situations, in the long run these can backfire and other governments can retaliate making it more difficult to construct a globally dispersed production system